Thursday, August 02, 2007

The List: Five Lies Economists Tell Us

The magazine Foreign Policy publishes some of the most incisive and considered analysis of foreign affairs, focusing on global politics, economis and ideas. Here's a post examining some standard beliefs, and their heretical facts. - MS

Economics prides itself on being the most scientific of the social sciences. Yet the X and Y axes can’t always capture globalization’s unpredictable turns. In this week’s List, FP looks at five ways in which the world economy is pushing economists to think outside the box.
High productivity and low unemployment make us all better off.
The orthodoxy: Economic theory does not guarantee that wages will reflect productivity in absolute terms, but most economists think that productivity-spurred growth will eventually increase everyone’s pie. SAJJAD HUSSAIN/AFP/Getty Images
Northwestern University economics professor Robert J. Gordon characterizes this view as, “productivity is the seed that creates the flower of a nation’s standard of living.”
Heretical facts: Despite six years of sustained growth, with unemployment averaging around 5 percent, the median U.S. worker is not faring well. Since 2001, middle-class Americans have seen their pay drop by 4 percent, although labor productivity went up by 15 percent during the same period.
Moral: Economists are still scratching their heads. Some labor economists point an accusatory finger at immigration. More of the foreign newcomers now hold advanced degrees, these economists argue, and native white-collar workers are no longer safe from cheap competition. Other economists point out that since China, India, and Russia joined the free market, the global supply of labor, including engineers and scientists, has quadrupled, pushing down wages. On the other side of the argument, the Peterson Institute for International Economics points out that globalization yields the United States around $1 trillion annually—or roughly $9,000 per year for every American household. Globalization skeptics, however, say that money is not making it into people’s pockets.
STR/AFP/Getty Images
It’s hard to grow without good banks and private property.
The orthodoxy: Economic growth requires a functioning banking system, solid property rights, and minimal state interference in the economy.
Heretical facts: One word: China. The gross domestic product of this Asian giant has increased sixfold between 1984 and 2004, with a stunning average growth of roughly 9 percent since 2005. Yet only in 2007 did the protection of private property acquire equal footing in Chinese property law. Moreover, experts still deem China’s banking system to be shaky despite a major overhaul that started in 2002. Harvard political economist Regina Abrami observes that the state has played a key role in the economic takeoff of the Chinese dragon. China’s township and village-owned enterprises—a curious mix of private initiative and government incentives—were for years at the heart of the country’s economic renaissance. And despite limited access to bank credit, China’s private sector has also thrived.
Moral: Growth happens—even when the market institutions that economists deem essential are not fully in place. Will China’s growth last? Nobody knows for sure, but many analysts have been arguing for some time that—as World Bank economic advisor Harry Broadman puts it—“the chickens could come home to roost, especially in the unreformed large, backbone, state-owned enterprises and banks,” precisely because of weaknesses in China’s underlying market institutions. For Broadman, the large scale of China’s internal market has been a key factor that has allowed the economy to prosper despite “fuzzy property rights.”

TIM SLOAN/AFP/Getty Images
Capital must always be let free to flow.
The orthodoxy: It keeps changing. Under the global financial architecture put in place soon after World War II, governments and multilateral institutions were to put some checks on where the money was going. But by the late 1950s, advocates of unfettered capital mobility were winning the argument, and under the so-called “Washington Consensus,” the U.S. Treasury Department and the International Monetary Fund recommended that developing countries lift restrictions over international movements of money.
Heretical facts: The Asian financial crisis. Starting in 1996, overvalued real estate prices collapsed in Thailand, spurring a devaluation of the Thai currency. Soon enough, the contagion spread to nearby Malaysia, Indonesia, and South Korea. Capital flight triggered painful recessions in most of East Asia. Only China and Taiwan, which had maintained tight capital controls, weathered the crisis unscathed. Malaysia split the difference by introducing capital controls in 1998, a last-minute attempt to avoid the worst.
Moral: Even though the jury is still out over the success of the Malaysian experiment, the Asian financial crisis was like a cold shower for enthusiasts of free capital mobility. Most economists now agree that letting the money flow is good, but only when the proper institutions and regulations are in place.

JOHN THYS/AFP/Getty Images
The euro will never work.
The orthodoxy: When, in 1992, 12 European heads of state gathered in Maastricht, the Netherlands, to announce the coming of a unified European currency, more than a few economists scorned them. History, wrote Nobel Prize winner Milton Friedman in the Wall Street Journal in 1995, had repeatedly shown that fixed exchange rates are simply a bad idea for “a group of large countries with independent political systems and independent national politics.”
Heretical facts: In January 2002, the euro made its entrance on the world stage and into the wallets of the citizens of 13 European countries. Five years later, it is still alive and healthy—stronger than the U.S. dollar, in fact. And despite grumbling from countries like Italy, where policymakers wish they could still boost exports by devaluing the old lira, nobody is seriously considering going back to single national currencies.
Moral: In a sense, the critics were right. One size does not fit all, and Europeans keep quarreling about where their centralized monetary policy should go. But the critics also missed the point. As Harvard political economist Rawi Abdelal explains, “The euro was not an economically motivated enterprise; its reasons to be were and are mostly political.”

Japan—no wait, China—is going to take over the world economy
The orthodoxy: Japan’s rise heralded the United States’ decline. In the mid-1980s, many economists looked at the Japanese economy—with its current account surplus, rising exports led by heavy car sales, and strong currency—and predicted dire consequences for Uncle Sam. Western analysts fretted over the United States’ ever-widening current account imbalance, decried the laziness of the U.S. worker, and lauded the efficient work ethic of the Japanese.
Heretical facts: As of 2007, the United States is still the greatest capitalist economy in the world, with a gross domestic product roughly three times as big as that of Japan, the world’s second largest economy. True, Japan’s car industry is still a rising star: Toyota briefly overtook General Motors a few months ago as the world’s largest automaker. Yet, as Newsweek columnist Fareed Zakaria put it, the Japanese “ran into a brick wall.” After more than 15 years of economic stagnation, repeated currency deflations, and record-high unemployment, the Japanese economy is just now coming out of the doldrums.
Moral: A rising tide lifts all boats. If Japan didn’t put Uncle Sam out of business, maybe China won’t, either. Martin Baily, a senior fellow at the Peterson Institute for International Economics, notes that for every Chinese worker, there is also a Chinese consumer joining the international market. What’s more, as Chinese salaries inevitably rise, it will become harder for Chinese companies to undercut the competition.